Why The Government Needs To Scrap The Bank Of England’s Inflation Target

The Bank of England is tasked with creating inflation every year. Inflation erodes the value of money – prices rise – and our wages don’t always keep up with the cost of living. So who benefits from this policy and who pays? We know who pays for inflation.  It’s the young people saving for a deposit who have those savings eroded, while first home prices are pushed further out of reach. House prices in the UK have benefited from dramatic inflation over the past fifty years and this has meant more and more people are left behind. What’s more, rents are going up and, right now, household bills are going ballistic.  Inflation drives the abject misery of ‘heating or eating’. 

Who benefits from rising inflation?

Governments tend to favour inflation as it erodes the real cost of repaying government debt; the warfare and welfare won’t cost quite so much to pay for if we inflate the debt away. Inflation can work as a stealth tax, by freezing a tax band so that more people must pay at that rate of tax. It can also be a stealthy way of reducing current expenditure; nurses get a rise, but not by quite as much as the real inflation rate. 

Those of us who own houses and other assets quietly know that we are at least protected from inflation.  In fact, our house prices always seem to go up by more than the official rate of inflation.  The property guys see their rents increasing, with the value of their buildings increasing too and the real value of what they owe the bank falling. Property is a good gig.  Inflation works for the banks as well.  They can lend more against rising property values and are protected should they ever need to rely on the value of their security.  Banking is a good gig too. Is there an inherent problem that the Bank of England should preside over a policy that seems to suit its industry?  

Inflation is the ultimate regressive tax

Inflation takes money from poorer people and transfers it to those with wealth, as well as to the government.  It enables governments to behave irresponsibly in relation to running up debts.  In enacting this policy and indeed in letting inflation get completely out of hand, the Bank of England is behaving as a latter-day Sheriff of Nottingham.

Moreover, the Bank of England is uniquely well placed amongst central banks to start getting a grip on inflation.  Through quantitative easing and suppressing interest rates, the bank has helped keep the Sterling at its lowest sustained value since the founding of the bank.  In such a free trading country as the UK – where we import much of the products we use – an improvement in our exchange rate against other major currencies would have the immediate impact of reducing inflation. 

The fact that the Bank has operated such a loose monetary policy in a period when the UK economy has been growing reasonably well and has record levels of employment is extraordinary.

It is almost as if the bank is trying to wilfully exceed its inflationary remit.

We are so used to inflation in our lives that it is easy to forget that it has not always been like this.  In the 100 years between the battle of Waterloo and the outbreak of WW1 the pound gained about 5% in value.  This marginal deflation is perhaps not surprising given the extraordinary advancement in technology and spread in trade that enabled many items in the shopping basket to become cheaper.  As always, for most people, the largest item in that basket was the rent or purchase of their home. The Victorians managed to reduce the cost of an average home from 14 times the average household income at the beginning of the 19th Century to three times by the end.

By contrast, in the 100+ years since the outbreak of WW1 - rather than gaining in value - the pound lost over 95% of its value.  Where a pound would buy 20 loaves of bread in 1914, it now doesn’t buy one.  Average house prices are back at nearly 10 times average household incomes.  The Victorians would have been proud of our amazing technological innovation and increase in trade.  They would have been horrified at how we have allowed much of the social benefit of economic success to be eaten away by inflation.  That inflation is a government policy is shameful. That inflationary policy has been allowed to get completely out of hand is criminal. 

Inflation got going in the West as a by-product of paying for the two world wars and later for the Vietnam war.  It became a policy of governments as it suits their desire for us to live beyond our means.  It simultaneously suited financiers and property people too.  A strange marriage of the state and capital that normally appear to be opposites in our society.

Final thoughts

I am not so sure the Bank of England shouldn’t be tasked with a policy of deflation.  House prices would become more affordable for Millennials and Gen Z. This could help reverse a long-running decline in homeownership.  Rents might fall.  A policy to undo some inflation would be novel.  Who would benefit and who would pay?

About the author: Sebastian Chambers is the author of The A-Z of Inequality, published by White Fox, priced at £10.00 and available at Amazon.co.uk.